24 January 2011

Keep the champagne on ice


Right, that’s it!  I’ve had it up to here* with both Enzo Raimondo and the Herald Sun (*blogger’s note - I’m pointing to my forehead).

Let’s start with Enzo Raimondo.  He’s the CEO of the Real Estate Institute of Victoria, whose “institute” relies on the voluntary reporting of sales results from real-estate agents.  Anyone see the credibility problem there?

Anyway, Enzo says house prices in Melbourne rose 7% in the last 3 months.  What?? Anyone watching the market knows that is crap and that the market flat lined, if not fell slightly, in the second half of 2010.

But whether you believe Enzo’s stats or not, my other problem is the media’s reporting of high house prices as a good thing.  The Herald Sun announced yesterday that:

"Melbourne home owners can pour the champagne - the median house price has smashed the $600,000 barrier for the first time."

This euphoria about rising house prices is either misguided or a sinister attempt to keep the bubble going a bit longer (an effective attempt, if my better half’s reaction - that we need to buy NOW - is anything to go by). 

I mean, how often do you read the headline:

"Melbourne drivers pop the champagne corks – petrol prices rise 20%" or

"Melbourne shoppers rejoice – grocery prices through the roof!"

How is paying each other ever-increasing amounts for shelter a good thing?  Well, let’s have a look at how it affects different groups:

Potential First Home Owners - Even the media understands that high house prices are not good for people trying to enter the market.  Although, property spruikers, with their love of metaphors, use this to claim that you’d better get on the ‘merry-go-round’ and start climbing the ‘property ladder’ before you ‘miss the boat’.

Existing Home Owners - I don’t understand why this group is supposedly popping the champagne corks. Sure they might feel richer but this wealth is illusionary. What is real is that when they come to upgrade, their rising house prices will just make this harder. 

For example, say you buy your first home today for $500,000 and have your eye on your dream home which is currently $1,000,000. If prices rise 20%, you’ll sell your first home for $600,000 and buy your dream home for $1,200,000.  Therefore, you’ll need to find (or borrow) an extra $600,000. 

However, if prices had fallen by 20%, you’d sell your first home for $400,000 (a loss) but your new home would now cost $800,000, not $1,200,000. So you’d only need to find (or borrow) $400,000 – and have $200,000 extra to spend on other necessities … such as mixed lollies and chocolates.

Property Speculators - Along with the media, banks and real-estate industry, property speculators, are the big winners when house prices rise.  Of course, if house prices unexpectedly fall, property investors who are negatively geared and relying on capital gains could find themselves in trouble.  

The Economy - People feel richer as their house price rise, encouraging them to spend more and go further into debt.  However, when the party eventually ends, people will feel the need to pay down their debt as quickly as possible, in order to avoid going into negative equity.  While this is a smart move, it will have a damaging impact on the economy. 

I predict a house price crash in Australian will cause a painful recession – but this is the unpleasant-tasting medicine we must take in order to get the economy on a more sustainable footing, rather than one reliant on ever-increasing debt. 

To conclude, when house prices go up, home owners should not be celebrating.  The economy should not be celebrating. We might feel richer but we are actually poorer.  The longer we pump up this housing bubble, the more painful the inevitable burst will be.

Comments and queries welcome.

Cheers,
Andy.

7 comments:

  1. I think it is of critical importance to ensure house prices do NOT go through the roof, because directing the extra cash toward mixed lollies and chocolates is far more important.

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  2. Hehehe. Look I like my mixed lollies and chocolate just as much, if not more than the next guy, but have you ever seen what an extra $50k of mixed lollies actually look like? So I think we can rid that myth and agree that nobody will will be putting their extra cash into their candy tooths, and put the extra dollars into their dream home instead. And so the cycle keeps going.
    Also not to mention that the only people who start poping the champagne when prices rise, are people who are selling after buying low.

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  3. All so true Andy. As we know, we have some of the highest priced housing in the world i.e. we are more enslaved by our mortgages and we have a much higher percentage of our income going to the mortgage that every other city in the world (with the exception of Vancouver I think). This means higher mortgage stress and less money to enjoy other aspects of life with and we are supposed to celebrate this fact?! What you believe all comes back to who you listen to and where you get your information from doesn't it? Unfortunately it is usually the people with a vested interest who shout the loudest.
    Keep up the excellent blog work!
    I would love to hear more about when you think a good time to buy would be and why. xx

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  4. Based on the highly publicised prediction from many banks that house prices will be flat this year, Why wouldn't these Baby boomers and others with SMSF sell their investment properties now and get more from a term deposit. I know i would. That simple thinking along with higher interest rates to come and better renting rates will definately cause a snowball affect that will see everything tumble. The question is...How many people are there like me...waiting for the pop therefore...They may strike pre-maturely causing for the pop sensation to turn out to be more of a fizzle...there for leaving many unsure of how this will turn out.... but everyone knows what direction. DOWN. But when will it stop...?

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  5. ulvit – exactly. In fact, what happens when prices are expected to flat line will be the topic of my next blog, which should be complete in a couple of days.

    To answer your question though, I think there are many property 'bears' like you, but I think if they have held out this long during the boom, many will be happy to continue holding out once falls become apparent.

    And just as the extent of the rise surprised us all on the update, I think the magnitude of the falls will surprise on the downside. I’m predicting prices to come down at least 40% over the next 5-6 years.

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  6. Thanks for the feedback csacker. As you know, buying a house to live in is not just a financial decision. But like any purchase, the cost needs to be weighed up against the benefit of owning (such as not getting kicked out by the landlord, being able to drill holes in walls etc).

    For me, the current cost of buying (compared to renting), is nowhere near worth the benefit. And seeing I’m predicting a 40% fall, I’d be happy to wait a few years. In the meantime, save hard because if house prices do fall by this amount, deposit requirements will increase dramatically.

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  7. In Jan 1990 interest rates hit a record high of 17%

    So how would this compare in todays housing market?...

    The 1990 Median house price was $100K with a 20% deposit & a loan of $80K payments @17% interest over 30 yrs would be $1140 pm or 32% of wages with average family wage of $42K pa...

    So in 1990 @ 17% the worst interest rates in Aust history payments only ever got to 32% of average family income...

    Fast Fwd to 2010 Median price reached $500K less 20% deposit & a loan of $400K payments @ 7% interest over 30 years are $2661 pm or 43% of wages with average family wage of $75K...

    So to get to 43% of wages going to house payments the payment would need to rises to over $1505 per month ... this works out to a interest rate of 22.5%

    In 2008 interest rates were 9.5% this would work out to payments of $3365 or 54% of current wages in 2008 .... or $1890 in 1990 this is equal to a 28.5% rate in 1990

    Now historically for the last 30 years interest rates have averaged 10.11% this would works out to payments of $3545 pm or 57% of wages going to mortgage payments ....or $1995 pm in 1990 this is equal to 30% rate in 1990....

    So summing up current housing mortgage payments @ 7% is still worse than when rates were at 17% but just imagine what will happen when rates rise?

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